U.S. DEPARTMENT OF ENERGY CLEAN ENERGY FINANCE GUIDE Chapter 12. Commercial Property-Assessed Clean Energy (PACE) Financing Third Edition Update, March 2013 Introduction Summary The property-assessed clean energy (PACE) model is an innovative mechanism for financing energy efficiency and renewable energy improvements on private property. PACE programs allow local governments, state governments, or other inter-jurisdictional authorities, when authorized by state law, to fund the up-front cost of energy improvements on commercial and residential properties, which are paid back over time by the property owners. PACE financing for clean energy projects is generally based on an existing structure known as a “land- secured financing district,” often referred to as an assessment district, a local improvement district, or other similar phrase. In a typical assessment district, the local government issues bonds to fund projects with a public purpose such as streetlights, sewer systems, or underground utility lines. The recent extension of this financing model to energy efficiency (EE) and renewable energy (RE) allows a property owner to implement improvements without a large up-front cash payment. Property owners voluntarily choose to participate in a PACE program repay their improvement costs over a set time period—typically 10 to 20 years—through property assessments, which are secured by the property itself and paid as an addition to the owners’ property tax bills. Nonpayment generally results in the same set of repercussions as the failure to pay any other portion of a property tax bill. The PACE Process *Depending upon program the structure, the lender may be a private capital provider or the local jurisdiction A PACE assessment is a debt of property, meaning the debt is tied to the property as opposed to the property owner(s), so the repayment obligation may transfers with property ownership depending upon state legislation. This eliminates a key disincentive to investing in energy improvements, since many property owners are hesitant to make property improvements if they think they may not stay in the property long enough for the resulting savings to cover the upfront costs. While residential PACE programs have faced regulatory opposition from the Federal Housing Finance Administration (FHFA) that has caused many programs to suspend operations, commercial PACE programs have not been directly affected and the model continues to offer governments an innovative way to support clean energy projects in the private sector. Clean Energy Finance Guide 12-1 March 2013 Update on Commercial PACE programs PACE programs have been launched in several regions of the U.S. and have utilized a variety of financing structures. While a few of the more established programs like Sonoma County’s Energy Independence Program (SCEIP) or Boulder County’s Climate Smart Loan Program have financed millions of dollars of improvements, most programs are new and have not yet financed significant volumes. At this point in the development of the commercial PACE market, there are several key policy discussions that are occurring around program design. These issues are outlined below: Program Standardization— PACE programs are somewhat fragmented since they are established at the municipal, regional, or state level. While programs often draw upon best practices, PACE programs have utilized a diversity of underwriting criteria, financing structures, and program procedures. Unfortunately the lack of uniformity of commercial PACE program creates an obstacle for contractors, mortgage lenders, and project lenders that serve larger geographies. For example, the state of California is already home to ten separate commercial PACE programs. Lender Consent— The vast majority of PACE programs require participating properties to secure either the consent or affirmative acknowledgement of any existing mortgage holders, because the assessment impacts the property’s debt burden, and in many cases may violate existing loan covenants. While many lenders ranging from community banks to major mortgage lenders have granted consent, the process of securing it is often a significant obstacle. The difficulty and time associated with securing consent has led some PACE program administrators to forego the requirement and simply notify lenders of the PACE assessment. However, controversy remains regarding the legal ramifications of placing the assessment without lender consent. In December 2012, PACENow published a survey of mortgage lenders1 that was funded by the Urban Sustainability Directors Network. While mortgage lenders did not broadly oppose PACE assessments, they strongly supported consent requirements and indicated they are generally more likely to consent to projects that improve the net operating income or value of the property. Unsurprisingly, lenders also noted that the overall debt load of a building and the pre-existing relationship with the owner would be key factors in granting consent. More insight into the best ways to approach lenders and standardize the consent/acknowledgement process is available in the PACENow report. Closed vs. Open Market— Programs have employed a variety of financing structures and have used both public and private sources of funding. Programs can generally be categorized either as 1) closed market programs that secure a line of credit from a financial institution or use public funds to provide project financing, or 2) open market programs which allow participants to choose among competing capital providers. More detailed comparison of these funding approaches can be found in Section 3 of this Chapter, Choose Capital Sourcing Approach(es). Demand— Although there is significant market interest in PACE, many commercial programs have experienced slow demand. This is likely partially due to the novelty of PACE as a financing mechanism. In order to jumpstart property owner interest, programs are utilizing a variety of marketing strategies ranging from free or subsidized audits, outreach to property owner associations, and marketing directly to commercial contractors. 1 Lender Support Study: http://pacenow.org/wp-content/uploads/2012/12/Lender-Support-Guide-12.28.20121.pdf. Clean Energy Finance Guide 12-2 March 2013 Is PACE the Right Choice? A summary of the key advantages and disadvantages of PACE for property owners is presented below. PACE Advantages PACE Disadvantages + Allows for secure financing of comprehensive — Available only to property owners; renters cannot projects over terms up to 20 years access programs directly — Cannot finance portable items + Repayment obligation passes with ownership, overcoming hesitancy to invest in longer payback — Requires dedicated staff time measures — High legal and administrative expenses to set up + Senior lien municipal financing may lead to low — Not appropriate for investments below $50,000 interest rates — Some resistance by lenders whose priority in default + The interest portion of assessment repayments are may be reduced. tax-deductible + Lower transaction costs compared to private loans + Allows municipalities to encourage energy efficiency and renewable energy without putting their general funds at risk + Taps into private capital, such as the municipal bond markets Overview of Steps to Launch Commercial PACE Local governments may follow these key steps to implement a commercial PACE program: 1. Review and Address Issues: Become familiar with issues related to PACE and factor their impact into program design and implementation. 2. Establish Supporting Framework: Lay a solid foundation for the program in the areas of team composition, goals, legislation, and assessment district formation. 3. Choose Capital Sourcing Approach(es): Choose whether the projects will be funded using private capital and if so whether the program will employ an open or closed market approach. 4. Determine if and how to Deploy Credit Enhancement: Decide how to achieve the best interest rates for the program and how best to apply and leverage any available funds to fit the program’s design. 5. Choose Eligible Property Types: Select the commercial property types eligible for the program. 6. Assemble Eligible Project Measures: Determine what types of improvements can be financed based on enabling legislation and program goals. 7. Choose Energy Audit Requirements: Decide the types of energy audits applicants will be required to undergo to assess expected project energy/cost savings. 8. Choose Program Eligibility Criteria: Determine the program underwriting/eligibility criteria that applicants and their properties must meet. Clean Energy Finance Guide 12-3 March 2013 9. Leverage Existing Utility Rebate/Incentive Programs: Investigate local utility rebate/incentive programs and how best to leverage them. 10. Plan Quality Assurance/Quality Control: Decide how the program will ensure that project work meets program quality standards and how to guard against fraud. 11. Design Application Processing Procedures: Design the process for reviewing applications and either approving or rejecting them. 12. Specify Contractor Requirements: Specify the requirements for energy auditors and contractors to participate in the program. 13. Market and Launch Program: Decide what kind of outreach will be made to property owners and contractors and launch the program. Note that many steps will be carried out concurrently and not necessarily in this exact order. In many cases, an additional step for a procurement process will be appropriate to